G20 to fix the world

US, Pittsburgh : US President Barack Obama greets British Prime Minister Gordon Brown (L) at the Phipps Conservatory for an opening reception and working dinner for heads of delegation at the Pittsburgh G20 Summit September 24, 2009.

The G20 group of developed and emerging nations will become a permanent body to guide the global economy. Fine words from Pittsburgh but what do they mean?

The US and China are leading this round of talks. They’ve got most influence on the two key topics: the dollar (meaning bailout the US and trying to stop Americans living beyond their means) and climate change.

The European Union is largely ignored, with nothing new to say and Germany distracted by elections at home.

A BIT OF HISTORY

The G6 back in the late 1970s represented the leading currencies: The dollar, the yen and the mark.

Other countries, like France, the UK, Italy, Canada, and most recently, Russia, gave the group more relevance but only the financial crisis that began in 2007 challenged the authority of the core founders.

In Pittsburgh, the US effectively declared it won’t try to run the world on its own. So what’s the plan?

MORE MEETINGS

Washington welcomed the final communiqué: “The G20 leaders reached a historic agreement to put the G20 at the centre of their efforts to work together to build a durable recovery while avoiding the financial fragilities that led to the crisis.”

In plain English, the G20 leaders promise not to be so blind to the financial bubble or whatever it was that messed up their re-election plans.

HOW VERY MBA!

Under the “global compact”, the leaders will set an agenda for the economy. Then, at meetings once or twice a year, leaders will give peer reviews in which they assess how their colleagues are doing.

How very MBA! The G20 ran out of ideas so they called in the consultants. “Er, we’ve got to look like we’re running the economy. What should we do?”

Peer review is how they do it at modern companies like Google. Colleagues assess and critique each other, thus raising the performance of the group.

However, staff at such companies are selected for high educational achievement, practical and analytical skills and, above all, common goals.

Secondly, peer review only works when colleagues have common goals. The US cannot behave as if it has a right to a higher standard of living than the rest of the world, and ask China to subsidise it.

CHINA RUNS OUT OF PATIENCE

What common interest can there be when the US devalues the dollar, through the electronic creation of new currency, and then tries to hand $3 Trillion of electronic bonds to the Chinese in return for more loans?

So far, the US has called its bluff. It thinks when China’s dollar holdings fall in value, Beijing will simply buy more US bonds (buying US bonds = lending money to the US).

However, China has run out of patience. A senior economic adviser Cheng Siwei warned “if they keep printing money to buy bonds, it will lead to inflation”.

Siwei was talking about quantitative easing, the latest wheeze in London and Washington. They say it’s to avoid deflation, to stimulate the economy but it’s just another way to bail out the banks.

Governments order the central banks to print money (actually, they do it electronically) and use it to buy assets from the banks for more than they are worth. The banks are supposed to lend the money to the economy but actually put it back in the vaults of the central bank and earn interest.

WHY ARE BANKS STASHING CASH?

The banks would rather earn 0.5% interest in the central bank than risk lending money to companies and individuals.

If the price of property, business, investments and loans keeps falling, how can anyone say the recession is over?

There are multiple ways to determine recession but one measure, two succession quarters of decline, is simple enough for headlines. Many indicators show the western economies still deep in recession, but by mid-year that decline had slowed.

It certainly doesn’t feel like the recession’s over:

* Lending by US, UK and Euro zone banks to the real economy has fallen every month for about the past six months
* Company defaults, like individual bankruptcies and mortgage defaults, are expected to rise sharply as they exhaust their reserves
* Consumers are spending less, on a narrower range of goods
* The dollar has fallen to its lowest for more than half a year, gold has jumped
* Another 10 million people in advanced economies will lose their jobs next year, on top of the 15 million who lost their jobs since the end of 2007, says the Organisation for Economic Co-operation and Development

Economics Student: “Wait, we’ve got the OECD. So why is the G20 creating another body?”

Professor: “You stupid boy. Go to the back of the class”.

BANKS ARE STILL INSOLVENT

So much for the strategy in Washington and London, but why should they care about the Chinese? The Chinese are worried about the west inflating away its debt.

The US and UK chose to prop up asset prices, allowing banks to avoid bankruptcy. Even today, those assets do not cover their debts. The banks are reported to have confessed to $1 Trillion of losses worldwide, only a portion of the estimated $2-3 Trillion that they lost. Many leading western banks are still insolvent. To keep them afloat, the governments have to go on printing more and more money.

Even in the biggest recession since the 1930s, the US continues to spend more than it earns. By mid-year, the US trade deficit was growing again as imports overtook exports. The US only manages that by borrowing from creditor countries like China.

MOVING APART

If China decides to cut its losses and switch from dollars into other currencies, the dollar will fall faster. That will present another huge risk to other nations who rely on dollar loans and investments, or whose currencies are closely-influenced by the dollar.

Economists agree with the G20 leaders when they call for reserve-rich countries and oil exporters to boost consumer demand, while over spenders like the US and UK reduce their deficits. That would bring the world economy closer to balance.

However the near term interests of the two biggest players at the G20 are moving further apart, not closer together.